I recently saw an interview with my second favorite economist, Professor Nouriel Roubini of the Stern School of Business, New York University. The interview given for The Asset Magazine in Hong Kong at was published on line. Professor Roubini gave a superb exposition of how the present recession hurts Asian economies. His forecast was that Asian economies could recover quickly because all they have to do was to change their policies from one of investment and export to one of domestic consumer consumption. If they changed policies, then domestic demand would take up the slack from the collapse of export demand. Since Asian domestic consumers have high rates of savings, they have more than enough cash to take up the slack. This thesis has also been suggested by many other economists. It won’t work.
Professor Roubini and his colleagues did not take into consideration the Osoyoos Indians.
The Osoyoos are a tribe of Canadian Indians living in British Columbia. According to The Economist, they, like their American cousins, have built a successful business by navigating the loopholes of the antiquated Canadian Indian Act. The act, according to the article, created a “system that is increasingly outdated, expensive and unworkable.” Yet it survives. It survives because there is “an army of lawyers, consultants and bureaucrats with a vested interest in the current system”.
Changing policy any policy requires changing laws. Laws, any law, exist because there is a group with a vested interest in that law. There are many people who have made and are making large amounts of money, because of the law. If the law is changed they may lose their businesses or their advantages. As a result of their profits, they have a powerful economic incentive to retain the status quo. A recent illustration is the reaction of the hedge fund and derivatives industry at the prospect of regulation.
It is also the main problem for the Asian economies. The Asian countries need to change their policies from a policy that encourages investment and export to a policy that encourages domestic consumer consumption. For example, to make up the hole in Chinese exports, the Chinese need to encourage spending. To do so will require them to change a plethora of laws including tariffs, taxes, subsidies, and regulations etc. In addition firms, usually state owned firms, would have to change their product lines, marketing, pricing, distribution chains etc. All firms especially state owned firms in China have some degree of political power. It is far easier for them to get bailouts or subsidies and try to wait out the recession than to make the vast changes necessary.
In contrast, many Asian countries including China, do not give consumers, the main beneficiaries of a policy change, much of a voice. Better education, health care and social security might discourage savings and encourage spending by Chinese consumers, but they probably will not get it. What you have is a free rider problem. There are a few firms and individuals who have large economic incentives to maintain the system and literally billons of free riders billions who would benefit from the change. Since the firms and individuals have not only money, but by definition exceptionally close ties to the government, the present export dominated policy will remain in effect regardless of any pronouncements about social safety net spending in the stimulus package.
If you doubt this thesis, look at Japan who has had an export dominated system for almost 60 years. If you doubt the difficulty in changing laws, look at the US tax code. Every country’s laws build up vested interests. The ability of a country’s laws to limit the power of those interests is crucial to the economic efficiency of the country’s economy. Without flexible legal systems, countries cannot adapt to crisis, downturns, technological changes, and shifts in global demands that inflict financial pain. Since most of the legal systems in East Asia do not have this flexibility, changing the model has been and will be very difficult. So the rapid recovery that Professor Roubini forecasts sadly will be delayed until export markets in more developed countries recover.
